Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.

Monday, 31 December 2012

The fiscal cliff is an extreme
example of what can go wrong when politicians are given a say in what stimulus
an economy should get: they use disagreements (fake or real) on what stimulus
an economy should get to push their own ideological agenda.

I’ve argued on this blog more than
once that politicians and the electorate should decide what proportion of GDP
is allocated to the public sector and how that money should be split as between
education, health, defence, etc. But stimulus decisions should be left to
technicians, which to a significant extent they already are. E.g. central banks
have a say in interest rates which in turn affect stimulus.

The latter split of
responsibilities as between politicians and technicians is also advocated in
this work which argues for full reserve banking. We’re a bright lot we
advocates of full reserve. Fiscal cliffs just wouldn’t happen if we ruled the
world.

Saturday, 22 December 2012

First: don’t under any
circumstances say anything original. The problem with saying something original
is this. Only about 0.1% of the human race produce original ideas, and only
about 1% recognise an original idea when it stares them in the face.

Thus if you set out an original
idea and send it in to some journal, there is only about a 1% chance of it
being published.

Second: far better is to take
some utterly banal idea, and present it in a slightly novel format, and add
some maths to make it look scientific. Here are some examples.

The Phillips Curve. It’s stark
staring bollocking obvious that there is some sort of relationship between
inflation and unemployment all else equal. That was known to anyone with more
than three brain cells long before Phillips took the idea and drew a graph to
represent the idea. David Hume (who had far more than three brain cells)
pointed to the relationship between inflation and unemployment about 200 years
ago. But that didn’t stop Phillips becoming a household name for his graph.

NAIRU. Well NAIRU is just a
trivial alteration to the Phillips curve. “Non Accelerating Inflation Rate of
Unemployment” just adds the idea that instead of inflation rising to some fixed
level when unemployment gets too low, it ACCELERATES. Yawn yawn.

The Laffer curve. For details on
the history of this, see Mike Norman here.

Or am I being too cycnical?

_________

P.S. (26th Dec. 2012).
The much heralded “Diamond-Dybvig” banking model is another example.Essentially all this model says is that “borrow
short and lend long”, which is what banks do, is risky. Only problem is that
that’s pretty much a statement of the obvious. Bagehot pointed to the dangers
of borrow short and lend long about 150 years ago. He said in reference to the
banking system, “But in exact proportion to the power of the system is its
delicacy, I should hardly say too much if I said its danger. . . . . Of the
many millions on Lombard Street, infinitely the greater proportion is held by
bankers or others on short notice or on demand; that is to say, the owners
could ask for it allany day they
please: in a panic some of the do as for some of it. If any large fraction of
that money really was demanded, our banking system and our industrial system
too would be in great danger.” (p.8 of “Lombard Street”).

And for comparison, here are the
first few sentences of the explanation of the DD model as set out by Wiki.

“The Diamond–Dybvig model is an
influential model of bank runs and related financial crises. The model shows
how banks' mix of illiquid assets (such as business or mortgage loans) and
liquid liabilities (deposits which may be withdrawn at any time) may give rise
to self-fulfilling panics among depositors. The model, published in 1983 by
Douglas W. Diamond of the University of Chicago and Philip H. Dybvig, then of
Yale University and now of Washington University in St. Louis, provides a
mathematical statement of the idea that an institution with long-maturity
assets and short-maturity liabilities may be unstable.

Presumably if someone set out a mathematical statement to the effect that daffodils flower in spring time, they'd be credited with discovering that daffodils flower in spring time.

Thursday, 20 December 2012

George
Selgin is an economics prof at University of Georgia, and I recommend his articles
and books to anyone. He has an encyclopedic knowledge of the history of
banking. Plus he writes in a clear, simple, witty style.

But in this
article he makes a criticism of the pro-full reserve Chicago school which does
not stand inspection. The particular Chicago individuals he cites are Irving Fisher,
Milton Friedman, Henry Simons and Loyd Mints.

But beware:
the arguments and counter-arguments are a bit complicated.

Selgin
claims that the above “full reservers” thought that the bank instability they
attributed to fractional reserve stemmed from variations in the public’s desire
to hold banknotes (as distinct from holding money in the form of deposits at
banks)

Selgin then
points out that by the 1930s, the production of banknotes by private banks was
virtually forbidden: i.e. the only form of banknotes were central bank or Fed
notes. And as he rightly points out, any increased desire by the public to hold
banknotes is a much bigger problem for a commercial bank where that bank cannot
produce their own notes, as compared to where it can. Reason is that when the
public withdraw central bank produced notes, that is a drain on a commercial
bank’s reserves, whereas if the commercial bank can produce its own notes there
is no such drain (and I’ll enlarge on that point below).

So, argues
Selgin, the instability was attributable not to any inherent flaw in fractional
reserve, but rather to commercial banks’ inability toproduce their own banknotes.

What did the Chicago school actually
say?

However, the
first big problem with Selgin’s argument is that the Chicago school advocates
offull reserve banking just didn’t
attribute instabilities to anything to do with banknotes - at least not as far
as I can see.

For example,
Fisher’s work “100% Money and the Public Debt” doesn’t say anything about note
withdrawal contributing to bank failures. What Fisher does say (p.10-11) is that
BANK RUNS were a big problem. And a bank run stems not from a change in how the
public wants to hold its money, but from a complete and total distrust of particular
banks.

And in a
paper of about 6,000 words in Econometrica entitled “The Debt-Deflation Theory
of Great Depressions” by Fisher, the words “banknote”, “note” and “cash” do not
appear.

As for
Friedman, he advocated full reserve in his 1948 paper “A Monetary and Fiscal
Framework for Economic Stability.”

But Friedman
certainly didn’t say anything about the demand for notes vis a vis demand for
deposits. Friedman just seems to be concerned about stability in general.

Moreover, it
is well known that Friedman’s main explanation for the 1930s depression was Fed
incompetence.

Whence the big cash withdrawals in
the 1930s?

The next big
problem in Selgin’s argument concerns the REASON why cash withdrawals were
taking place in the 1930s. Well it’s not too hard to fathom, and it’s nothing
to do with random variations in the amount of physical cash that people wanted
to hold. The explanation was that banks were toppling like nine pins in that
decade, thus many people rather than keep a deposit in their local tinpot bank,
preferred to hold notes produced by the Fed, the US central bank. Those notes
were as good as gold. Deposits in your local tinpot bank were quite likely
nowhere near as good as gold.

Selgin tries
to wriggle out of the latter point with the following.

“But while
the notes of certain banks would undoubtedly have been distrusted . . . . plenty of banks remained both trusted and
solvent, and their notes could have supplied the needs of the country as a
whole, since notes (unlike bank deposits) can travel wherever they are most
wanted.”

Well I
suggest that is just plain unrealistic for 1930s America. To illustrate, if you
lived in Southern Missouri were you really likely to see many banknotes issued
by the Bank of San Francisco? And even if you did see some of them, would you
really trust them given that you’d have known that banks were failing left,
right and centre? Is a farmer in Southern Missouri really likely to be an
expert on the credit worthiness of the ten thousand banks that existed around
America at that time?

The
demand for physical cash at harvest time.

Another
possible explanation for withdrawals of banknotes is a phenomenon to which
Selgin himself draws attention on some of his articles, namely that in the
1800s and early 1900s there was a significant increase in demand for banknotes
at harvest time. Reason is that farmers came by large amounts of money at that
time of year on selling their crops and they then spend a proportion of that in
goods in their local town. In short, given a rise in economic activity, there
is a rise in demand for banknotes.

But the
1930s were hardly a period of above normal “economic activity”. Quite the
reverse.

That is, far
from the increased demand for banknotes being attributable to a boom, there
must have been some other reason for people withdrawing banknotes from banks.
And it’s obvious enough what that reason was: it was, to repeat, the fact that
they didn’t trust their local tinpot bank.

To summarise
so far, it looks like Selgin’s criticism of the Chicago school full reservers
needs a lot more work before his argument can be described as “robust”.

And finally
I’ll expand, as promised, on the private bank note production versus central
bank note production question.

Private banknote production.

Where
private banks can issue their own banknotes, those notes as far as the bank is
concerned are little different to deposits. That is, if customers of a
particular bank suddenly decide they want to raise the proportion of their
money held in physical cash rather than in deposits, that is of no great
concern to the bank: the bank can quickly print extra notes if need be. As
mentioned above, that happened regularly at harvest time.

In contrast
to letting private banks print their own notes, there is the regime we are all
used to nowadays, namely a regime under which only the central bank produces
banknotes. But that raises a problem for private banks when their customers
want to hold more banknotes: the problem is that private banks have to eat into
their reserves to obtain those central bank banknotes, as pointed out above.

Now if a
bank is going to stick to a prudent level of reserves, or to a legally enforced
level of reserves, that means that when customers decide to hold more
banknotes, a private bank will have to call in loans, or temporarily cease
granting loans, which of course has a deflationary effect. And it’s an effect
you just don’t need in the middle of a depression like the 1930s depression.

Worse still,
if the relevant bank COULD NOT call in loans then bank faced insolvency. So
Selgin’s claim that forbidding private banks from issuing their own notes makes
life more difficult for commercial banks than if the latter are able to produce
their own notes is certainly valid. But that point is completely irrelevant
where withdrawals take place because people DON’T TRUST the bank at all.

Japan would be well advised to
take the advice given them by this recent ING publication authored by
TanweerAkram with a large pinch of
salt.

The one good bit of advice is
that Japan should not “obsess about fiscal consolidation”. That is simply a
re-wording of Keynes’s entirely correct observation: “Look after unemployment
and the budget will look after itself”.

But its downhill from there on.
For example Akram tells the Japanese (p.24) to “increase the public investment
share of real GDP”. Why on Earth? If there was evidence that Japan had
insufficient public investment, then OK. But Akram produces no such evidence.
In fact Japan is littered with examples of EXCESS investment in public sector
stuff: those famous “bridges to nowhere”.

Next, the Japanese are told to focus
on policies that “promote labor-intensive aggregate demand”. Well I’m afraid
the idea that concentrating on labour intensive activity creates more jobs than
capital intensive activity is a hoary old myth. Reason is that there are only
about three ultimate costs of which labour is much the biggest.

What I mean by “ultimate cost” is
this. In the case of capital intensive production, the capital equipment
requires labour and capital equipment for its production. And the latter
capital equipment requires labour and capital equipment for its production. And
the latter capital equipment requires labour and capital equipment for its
production. Get the picture? The ULTIMATE cost is labour. So the amount of work
created by spending $X on a capital intensive activity is ultimately the same
as that created by spending $X on a labour intensive activity.

As to how many “ultimate costs”
there are, that’s a bit debatable. There are arguably four: labour, interest
for capital, rent for land and profits. However, interest on capital and profit
could be construed as the “labour” of the entrepreneur. So there are arguably
between two and four ultimate costs depending on your definitions.

So to put it more accurately,
there is no reason to suppose that ratio of ultimate costs involved in labour intensive
activity is any different to the equivalent ratio for capital intensive
activity. Thus the idea that spending $X on labour intensive activity
ultimately creates more jobs than spending the same amount of capital intensive
activity is not true.

International trade.

The above point about capital /
labour intensivity being irrelevant is certainly true for a closed economy. As
to open economies, the point is basically also true – it’s just that the
arguments are a bit more complicated. For example if a country spends on
capital intensive activity, a fair proportion of the capital equipment can be
IMPORTED. And that of course creates work abroad rather than at home.

However, that just causes a
deterioration in the balance of payments, which depresses the currency relative
to other currencies, which (if market forces are working) will bring the
balance of payments back into balance.

“Employment programs”.

Next Akram advocatres“large-scale employment programs — in health
care, services for the elderly, environmental protection….”. Well hang on –
governments already spend large amounts on “health care, services for the
elderly and environmental protection”. What’s the point of “employment programs”
that duplicate that effort?

Given a GENERAL EXPANSION in
Japanese GDP, both private and public sectors will expand. And expanding the
latter will AUTOMATICALLY bring an expansion in spending on “health care,
services for the elderly and environmental protection”. It’s all hogwash.

Of course Akram could have argued
that if the economy is at capacity, i.e. the point where attempts to boost
economic activity result in inflation rather than additional output, there is
arguably a case for his “large-scale employment programs”. Unfortunately he is
light years behind the times on this subject. He is still wet behind the ears.
Put another way, he has almost got as far as understanding the opening
sentences of this work of mine that looked at “large-scale employment programs”.

Hopefully he will study the
literature on this subject before expressing any more views on it.

Non-peer reviewed (or only lightly peer reviewed) publications. The coloured clickable links below are EITHER the title of the work, OR a very short summary (where I think a short summary conveys more than the title).

i) The above is not a complete list in that earlier versions of some papers have been omitted. For a more complete list see here, and “browse by author” (top of left hand column).

ii) 7 deals with a wide range of alleged reasons for government borrowing, including Keynsian borrow and spend. 6 is an updated version of the "anti-Keynes" arguments in 7. 5 is an updated version of 1, which in turn is an updated version of 4.

______________

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Bits and bobs.

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As I’ve explained for some time on this blog, the recently popular idea that “banks don’t intermediate: they create money” is over-simple. Reason is that they do a bit of both. So it’s nice to see an article that seems to agree with me. (h/t Stephanie Schulte). Mind - I've only skimmed thru the intro to that article.________

Half of landlords in one part of London do not declare rental income to the tax authorities. I might as well join in the fun. I’ll return my tax return to the authorities with a brief letter saying, “Dear Sirs, Thank you for your invitation to take part in your income tax scheme. Unfortunately I am very busy and do not have time. Yours, etc.”________

Simon Wren-Lewis (Oxford economics prof) describes having George Osborne in charge of the economy as being “similar to someone who has never learnt to drive, taking a car onto the highway and causing mayhem”. I’ll drink to that.

Unfortunately SW-L keeps very quiet, as he always does, about the contribution his own profession made to this mess. In particular he doesn’t mention Kenneth Rogoff, Carmen Reinhart or Alberto Alesina – all of them influential economists who over the last ten years have advocated limiting stimulus (because of “the debt”) if not full blown austerity.________

Plenty of support in the comments at this MMT site for the basic ideas behind full reserve banking, though the phrase “full reserve” is not actually used.________

Old Guardian article by Will Hutton claiming the UK should have joined the Euro. Classic Guardian and absolutely hilarious.________

One of the first “daler” coins (hence the word “dollar”) weighed 14kg.!!! Imagine going shopping for the groceries with some of those in your pocket, or should I say “in your wheelbarrow”. (h/t J.P.Koning)________

Moronic Fed official reveals that GDP tends to rise when population rises. Next up: Fed reveals that grass is green and water is wet….:-)________

Fran Boait of Positive Money says the Bank of England "has no capacity to respond to a future crisis, and that puts us in an extremely dangerous position." Well certainly there are plenty of twits at the Treasury and at the BoE who THINK responding will be difficult. Actually there's an easy solution: fiscal stimulus, funded (as suggested by Keynes) by new money. Indeed, that’s what PM itself advocates. But it’s far from clear how many people in high places have heard of Keynes or, where they have heard of him, know what his solution for unemployment was.________

The US debt ceiling has been suspended or lifted 84 times since it was first established. You’d think that having made the Earth shattering discovery 84 times that the debt ceiling is nonsense, that debt ceiling enthusiasts would have learned their lesson, wouldn’t you? I mean if I got drunk 24 times and had 24 car crashes soon afterwards, I’d probably get the point that alcohol causes car crashes…:-) As for getting drunk 84 times and having 84 car crashes, that would indicate extreme stupidity on my part. No?________

The US Treasury has the power to print money (rather in the same way as the UK Treasury printed money in the form of so called “Bradburies” at the outbreak of the first World War).________

“Payment Protection Insurance” was a trick used by UK banks: it involved surreptitiously getting customers to take out insurance against the possibility of not being able to make credit card or mortgage payments. UK banks have been forced to repay customers billions. But that’s just one example of a more general trick used by banks sometimes called “tying”: forcing, tricking or persuading customers to buy one bank product when they buy another. More details here on the Fed’s half-baked attempts to control tying in the US.________

The farcical story of economists’ apparent inability to raise inflation continues. As I’ve long pointed out, Robert Mugabe knows how to do that. In fact Mugabe should be in charge of economics at Harvard: he’d be a big improvement on Kenneth Rogoff, Carmen Reinhart and other ignoramuses at Harvard.________

I’ve removed comment moderation from this blog. The only reason I ever implemented it was so as get rid of commercial organisations advertising something and posing as commenters. When doing that I noticed comments were limited to people with Google accounts for some strange reason. Removed that as well. ________

Article on money creation by Prof Charles Adams, who as far as I can see is a professor of physics at my local university – Durham. I can’t fault the first half of his article, but don’t agree with the second half which claims both publically and privately issued money are needed because we have a public and private sector. I left a comment.

Adams is nowhere near the first physicist to take an interest in money creation. Another is William Hummel. These “physicist / economists” are normally very clued up (as befits someone with enough brain to be a physicist).________

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MUSGRAVE'S LAW SOLVES THE FOLLOWING PROBLEM.

The problem. Deficits and / or national debts allegedly need reducing. The conventional wisdom is that they are reduced by raising taxes and / or cutting government spending, which in turn produces the money with which to repay the debt. But raised taxes or spending cuts destroy jobs: exactly what we don’t want. A quandary.

The solution. The national debt can be reduced at any speed and without austerity as follows. Buy the debt back, obtaining the necessary funds from two sources: A, printing money, and B, increasing tax and/or reduced government spending. A is inflationary and B is deflationary. A and B can be altered to give almost any outcome desired. For example for a faster rate of buy back, apply more of A and B. Or for more deflation while buying back, apply more of B relative to A